By Matthew Cushen
A traumatic 2020 has closed with the hope and expectation that multiple vaccines will allow lives to return to normal (sometime) during 2021. It helpful we can see the light at the end of the metaphorical tunnel, particularly so for growth investors that have the end of the tax year in mind for taking advantage of the generous tax reliefs afforded by the Enterprise and Seed Enterprise Investment Schemes (EIS & SEIS).
We are regularly being asked to comment on the impact of Coronavirus – on valuations, on risk and on the availability of early-stage deal flow.
Perspective 1: the pre-corona context
Many seed investors have seen valuations getting ‘frothy’, or in some cases egregious, for a while. There has been an overweighting of the potential of good ideas with little proof of concept/customer demand. This seems to be particularly true of crowdfunding, probably as there is not a proper objective conversation between entrepreneur and investor. High valuations going in substantially impact the returns multiples on exit and we have seen too many deals where the potential returns do not justify the risks of early-stage investing.
Perspective 2. Teasing apart short term & structural changes
It’s hard to find businesses that have been unaffected by the pandemic. Whilst the media focuses on the many negative impacts, there are also many businesses that have been positively impacted. But in both cases, for decisions about future investment, it’s important to tease apart the short-term impact of lockdown from the long-term impact of systemic changes to consumer and business behaviours.
When the pandemic broke, we moved quickly to help our portfolio businesses understand the impact and how they had to change their priorities. For the first few weeks, we struggled to comprehend the full impact. This has since become clearer and we use this simple matrix to frame our thinking.
I’ve included 5 examples from our portfolio:
Weekly10: subscription software for companies to measure and improve employee engagement and business culture, and performance on business objectives and goals.
The immediate impact of the lockdown was to suspend all the conversations they were having. But they were fortunate to have launched their Microsoft Teams add-in a fortnight prior to European/North American lockdowns (to add to the desktop, iOS, Android & Slack versions). Then fundamentally, they are perfectly positioned to take advantage of a long-term shift to remote working – one which we anticipate finding an equilibrium that is less than during lockdown but much more than pre-pandemic. Therefore, the job here was to shift the sales & marketing effort from a sector-based strategy to maximise short term customer acquisition driven by remote working. Since then they have been adding customers quickly and now their more strategic conversations are starting back up again.
Bedfolk: direct to consumer retailer of their own ethically produced, high-quality bedding.
They had already been growing very quickly – delivering 25% more sales than promised between our first investment in April 2019 and April 2020. Concurrently with further improving their brand, marketing and introducing a new product, they have benefitted from a huge increase in eCommerce whilst shops have been closed and a particularly marked increase in spending on homewares as consumers spend more time at home. Their proposition, centred around nesting & wellness, is well-positioned for current, and we expect continued consumer sentiment. At some point, they will lose the homewares tailwind but the long-term shift to eCommerce is here to stay, so we are confident they will maintain a strong growth trajectory, maybe just a little less spectacular.
Vitrue Health: smart motion detection and depth-sensing hardware and software for physiotherapists & orthopaedic surgeons assessing & treating musculoskeletal (MSK) conditions.
The lockdown has been difficult as it curtailed some very successful event-based selling activities. But the team changed their approach quickly to both selling (going to virtual demos) and to product development, including a smart and timely method of assessing posture through a webcam, so posture assessments can be conducted at scale for home offices. Their solution – that has patients in an out more quickly than a current assessment – should prove a little more attractive as physiotherapists return to their practices with a reduced capacity. And the increase in home working is not reducing the incidence of poor posture! So, whilst they lost and then regained momentum through lockdown, the proposition is a net a little positive for the long term.
Zobi: has a first product, the Hedgehog, a patent-pending cybersecurity device using artificial intelligence to discern between routine and non-routine communication between Internet of Things (IoT) devices on a network.
Zobi is pre-revenue, busy getting their first production run started and finalising their software. For which there has been no impact of lockdown. There is maybe a slightly positive impact in the long term, as more people are working from home, so more corporate IT boffins are getting exercised by home network security – exactly Zobi’s target market.
Nightly: a new way to book hotels – giving travellers the option to switch hotels once during their trip to get the best value, a different experience and save as much as 70%.
Unfortunately, a devastating impact of lockdown – zero revenue. Then we expect the increased hassle of travelling over the next 18 months (at least) and sensitivity to turnaround times (for both traveller & hotel) makes their core proposition much less attractive long-term. This is the one business in our portfolio that we have directly lost as a result of the pandemic.
Perspective 3. Macro-economic spending & investment
Our view (lightly held – this is evolving) is that consumer and small business spending will, of course, be heavily impacted but that it will be polarised. There are plenty of individuals and small businesses that have not had their income impacted by lockdown and have some pent-up disposable income to splash. But sadly, there will be swathes of unemployment, and the pain to a large extent looks likely to be felt by those that were suffering before, in a further widening of the wealth gap. So we expect premium products & services (like Bedfolk or Zobi) to be less impacted by consumer spending slowdown than those targeted at a more mainstream audience (likely Nightly). Business investment appetite is very sector-specific, but we expect enlightened businesses, that have the cash flow, to continue to invest. For a business like Weekly10 that appeals to progressive leaders looking after high-value employees, this could bode well. For those like Vitrue Health selling to large & small healthcare providers, that are likely to have been heavily cash impacted, this might prove to be a headwind.
Perspective 4: Supply of & demand for funding
There is evidence that during 2020 early-stage funding slowed up and most deals seem to be a follow-on from existing investors, with the occasional business that has a short-term opportunity and needs cash to fund it fast. We see pent-up demand for funding that is likely to lead to downward pressure on valuations.
It’s difficult to predict how the supply will pan out over the medium term. Clearly, investor sentiment is impacted by losses in public equity markets, but equally many investors see that early-stage businesses are less impacted by global turmoil. Young businesses are generally quicker to adapt. They have relatively little revenue to lose, cash flow is more driven by spend – when resources become cheaper. Although inherently high risk/high return, the relative risk between seed investing and public equities narrows when risk with public equities increases.
So, I’ve laid out some forces at work and some examples. Whilst studiously avoiding a broad-brush prediction of decreasing or increasing valuations and risk. The pandemic, and more importantly the longer-term changes to behaviours that result, will have an impact. But, as ever, macro impacts impact different businesses differently.